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Edited Transcript of ALRS.MZ earnings conference call or presentation 22-Aug-19 1:00pm GMT

Q2 & H1 2019 AK Alrosa PAO Earnings Call (IFRS)

Moscow Aug 26, 2019 (Thomson StreetEvents) -- Edited Transcript of AK Alrosa PAO earnings conference call or presentation Thursday, August 22, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexey Nikolaevich Philippovskiy

Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee

* Sergey Takhiev

Public Joint Stock Company ALROSA - Head of Corporate Finance

* Sergey Sergeevich Ivanov

Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board

* Yevgeny Yuryevich Agureyev

Public Joint Stock Company ALROSA - Director of United Selling Organization & Member of the Executive Committee

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Conference Call Participants

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* Anna Antonova

JP Morgan Chase & Co, Research Division - Analyst

* Anton Fedotov

BofA Merrill Lynch, Research Division - Analyst

* Boris Sinitsyn

VTB Capital, Research Division - Equities Analyst

* Stella Cridge

Barclays Bank PLC, Research Division - Head of EEMEA Corporate Credit Research

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Presentation

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Operator [1]

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Ladies and gentlemen, welcome to ALROSA Second Quarter 2019 IFRS Conference Call.

I will now hand you over to your host, Mr. Sergey Takhiev, Head of Corporate Finance. Sir, the floor is yours.

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Sergey Takhiev, Public Joint Stock Company ALROSA - Head of Corporate Finance [2]

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Thank you. Good morning and good afternoon, ladies and gentlemen. My name is Sergey Takhiev, Head of Corporate Finance, and I'm honored to conduct conference call of ALROSA. Thank you for joining us today in -- on our conference call to discuss ALROSA financial performance in the second quarter 2019.

As always, elements of our presentations are forward-looking and are based on our best view of the market. Company's CEO, Sergey Ivanov, will discuss key operating and financial highlights and key developments at the company; and our CFO, Alexey Philippovskiy, will discuss our second quarter financials, and then we'll be happy to take your questions. Today, Yevgeny Agureyev, Head of United Selling Organization is joining us today and will be happy to answer your questions as well.

That's all on my side. And I hand over the call to Sergey Ivanov.

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Sergey Sergeevich Ivanov, Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board [3]

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Dear colleagues, I am happy to welcome you at our second quarter 2019 results conference call. The financial results have been published on Monday. And I'm sure that you have enough time and have seen our MD&A already. So mindful of your time, I would like to say a few words on the diamond markets and recent developments. Then I will pass the floor to Alexey Philippovskiy, who will discuss our financials in more details.

In 2019, we saw a number of factors that affected our markets. On the jewelry demand side, following a strong growth in jewelry demands in 2017 and '18, when diamond jewelry sales reached RUB 86 billion, an all-time high, the demand started to decelerate in late 2018. And the trends well continues in 2019, largely due to rising trade tensions and growing macro uncertainty. This along with our ongoing growth of share of online jewelry sales led to an increase in jewelry stocks at retailers, and as a consequence, weaker demand for polished stones.

Another important factor, which probably has even stronger impact on the whole diamond pipeline is the ongoing financing difficulties faced by the midstream in India, where 90% of rough stones are processed. This factor along with reduced order book from retailers and softer demands turned the industry into destocking cycle.

Coming to Slide #3. Mining industry responded with reduced supply. And as you see on this slide, major producers reduced sales by 23% in the first 6 months of 2019. Industry-wide reduction in sales comes with a continued decrease in global rough diamond production, underscoring long-term supply tightness of the diamond market. As you see from the chart on this Page 3, in first 6 months of 2019, diamond production was down by 2% on mines capacity rationalization. In order to hold back pressure on the market and support the process of stock level normalization in the system, we keep implementing our balanced sales strategy with price-over-volume approach. This led us to revise our 2019 sales outlook to -- from 38 million to 32 million, 33 million carats. At the same time, we update our production guidance with increased output by 0.5 million carats to 38.5 million carats. And this growth is coming from increased productivity gains and strong ramp-up at our newly launched assets. And I would be ready to comment on this issue further as I expect there will be questions why are we ramping up production and showing increases in production guidance.

We understand that these gains will be realized as the market supply/demand balance is restored. As for the short-term outlook, a seasonal growth in the months by year-end coupled with continued reduction in stocks, both at retailer and polishers as well as disciplined decrease in rough supply by miners, will bring the market back to the balance again. We remain strong believers in attracted fundamentals on the diamond market as our high-quality portfolio of assets is well positioned to generate value to our shareholders.

At this, I'm handing it over to Alexey, our CFO. Alexey will walk you through the company's financials. And then we're ready to take your questions. Thank you.

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [4]

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Good day, ladies and gentlemen. As many of you already saw the presentation and the release published on Monday, I would like to briefly take you through the key highlights and give more details on the frequently asked questions we received so far.

To start I would suggest you go to Page 5 with our production numbers. Our Q2 production in carats was seasonally up 24% quarter-on-quarter. The year-on-year growth of 14% was due to the new output coming from Verkhne-Munskoye facility launched last year, efficiency improvements at Nyurba Division. And better grades at Severalmaz and Udachny reached -- drove group grades by 10% on a year-on-year basis.

As Q2 output went up and sales came lower, and we discuss this on Slide #7 (sic) [Slide #6], diamond stocks increased by 1.6 million carats to 15.7 million (sic) [15.9 million] carats. Destocking at midstream and at retailers was behind both lower sales and softer pricing index, as you can see on Page #8. Second quarter price index decreased by 1.6%. Though I would like to point your attention that the decline decelerated from minus 2.6% in Q1.

Second quarter growth in average realized prices for gem quality diamonds of 5% was largely due to a lower base of Q1, when average price was impacted by higher-than-average small stone sales in our sales mix.

Now let me take you through key financial highlights for the second quarter. Our revenue was down 19% quarter-on-quarter to RUB 57.4 billion, mainly due to lower sales volumes, and this decline was partially offset by growth in average realized prices on a better mix.

Second quarter total costs were down by 18% quarter-on-quarter to RUB 32.2 billion, mostly due to, again, lower sales volumes. And our unit cost both in cubic meters and in carats decreased as we increased production, while nominal cost kept largely unchanged. Our second quarter EBITDA was down by 20% against Q1 to RUB 25 billion, mainly impacted by lower sales volumes. Profitability stood steady at 44%, unchanged against the first quarter.

Second quarter CapEx grew by 17% quarter-on-quarter or it was down 37% year-on-year to RUB 4.5 billion, mainly due to seasonal increase in technical upgrade investments and growth in the rough diamond development CapEx.

I'd like to mention that the update -- our CapEx guidance for 2019, decreasing from RUB 28.6 billion to RUB 23 billion. This decrease will not impact our operational performance.

Our total debt went down by 14% to $1.4 billion, the lowest level since 2013. Our debt maturities further extended, following the successful placement of our 5-year Eurobond and partial buyback of the existing bonds issued. Cash position stays healthy at $853 million and our net debt-to-EBITDA ratio remains at 0.3x, which is well below our targeted levels.

Our first half of 2019 free cash flow stood at RUB 28.2 billion. However, the free cash flow in the second quarter was down to RUB 2.4 billion, impacted by lower earnings, seasonal CapEx growth and increases in working capital.

The working capital increased by 15% quarter-on-quarter and by 15.4% year-on-year as a result of: first, increase in rough diamond inventories, 4% quarter-on-quarter or 44% year-on-year as production in the second quarter of 9.7 million carats exceeded sales of 8.3 million carats; second, a seasonal growth of 18% quarter-on-quarter in ore inventories by RUB 3 billion, which was primarily driven by our alluvial deposits; seasonal rise in supplies of fuel, spare parts, material, et cetera, by RUB 3.7 billion, triggered by the start of the litigation period of the Lena River in May, June; rise in trade and other receivables by 2.5 -- RUB 2.9 billion, due -- mostly due to an increase in value-added tax claimed for reimbursement; and finally, the decrease in trade and other payables by RUB 3.3 billion, mainly due to decrease of advance payments we received from our customers from RUB 3.1 billion to RUB 1.4 billion.

A few words on dividends, more details on Page #17. On June 26, our shareholders approved H2 2018 dividends, 100% of free cash flow for the period, RUB 30.3 billion. Next week, on Monday, our Board will discuss first half 2019 dividends. And based on our new dividend policy and current metrics, there is a good chance we will see 100% of FCF for the first half of the year to be recommended for the dividend payments.

Before we conclude our presentation, I would like to say that despite some of the headwinds that we saw in the first and second quarter of this year, the long-term fundamentals for the jewelry demand growth remains strong in both developed and emerging markets. We believe that in the second half of the year, market will continue to gradually restore supply and demand balance. Supply of rough diamonds, as you see, was quickly adjusted, while polished stocks at midstream are expected to decrease as high demand season approaches.

This concludes my part of the presentation. And now we are ready to take your questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question from Boris Sinitsyn, VTB Capital.

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Boris Sinitsyn, VTB Capital, Research Division - Equities Analyst [2]

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Three questions from our side, please. The first one is on most recent news. As far as we understand, last week you had your August sites. And the question is what trends do you see on this site, both compared with July and compared with normal situation for August?

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Yevgeny Yuryevich Agureyev, Public Joint Stock Company ALROSA - Director of United Selling Organization & Member of the Executive Committee [3]

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Agureyev, [Yuryevich] speaking Head of United Selling Organization. We started our August site this week. And we started our sales in parallel with the other mining company. And as we see so far, the demand is in the same mode as it was in July. So it's important to mention that we are -- now at this period of time, it's low-demand period of time, taking into account seasonability. But our expectations so far are on the same level as July, as last month.

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Boris Sinitsyn, VTB Capital, Research Division - Equities Analyst [4]

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Okay. That's very helpful. I've got the second question on the level of prices in the second quarter. So the question is how do you see the mix, the average mix for gem-quality stones, which you saw in the second quarter compared with, I would say, normal mix of your production. Do you expect that the mix was still below by your normal level or higher? And what are your expectations for the next several quarters in terms of mix performance?

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Yevgeny Yuryevich Agureyev, Public Joint Stock Company ALROSA - Director of United Selling Organization & Member of the Executive Committee [5]

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I will follow. Thank you for the question. Regarding the mix, we can say that during this year, we saw different trends, and we started with the year with quite good demand for the low sizes, and there are some reasons for this demand. Now during the middle of the year, we see that we have quite a good demand for full range of positions. So we see some recovery on the middle-sized stones. Also there is demand for big sizes stones. So I think that in average, we'll see the balanced demand for the second half of the year.

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Boris Sinitsyn, VTB Capital, Research Division - Equities Analyst [6]

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Okay. And my last question is on, like, ways of returning capital to shareholders, given recent underperformance of the stock price, does the management consider any other means of return of capital to shareholders other than dividends, for example, buybacks?

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [7]

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This is Alexey. No. At this point, we do not consider this. And the reason is that we would like to preserve the availability of our shares and the relatable large portion of the free fall. It does not mean that we will not consider it in the future.

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Operator [8]

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Our next question, from Anton Fedotov, Bank of America Merrill Lynch.

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Anton Fedotov, BofA Merrill Lynch, Research Division - Analyst [9]

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Right now you have quite a significant gap between your production and your sales. If the current market weakness continues into the next year, may you consider a cut in your production numbers next year versus the current year?

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Sergey Sergeevich Ivanov, Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board [10]

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I'll take this question. So our production is driven primarily by sales forecasts and economics. And these -- the revised upwards volume, we disclosed on Monday, is coming from the operational efficiency program we announced last year. So it comes at almost 0 cost or CapEx, just through more efficient use of equipment and revision of the processes in operations. This is important for us as we apply lean practices at our operations and want them to last and become part of our culture. The cost structure of most of our mine operations, as you know, is very high. There is a very high share of fixed costs. For underground mining, the share of fixed cost is over 80%. For open pits, it's around 70%. And for alluvials, we have higher variable cost structure. So it gives us limited flexibility, I guess, within 5% to 7% for the production. But as for guidance for next year -- so we're now looking into different options and discussing it within the company. So I think beginning of -- end of September, we will have some news to report on the production guidance for next year. If the reduction was supported by less cost and less CapEx, we might look into these issues. But we have to be very careful because if it -- if these reductions do not bring us cost efficiency, then there's a question whether we should proceed with it. And as we mentioned several times, so sometimes, keeping higher stock in our vaults is -- could not be a bad strategy because we understand the jewelry. The retail is doing quite fine, and we've seen cases when our company was able to sell much higher volumes then we were producing. Thank you.

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Operator [11]

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Our next question is from [Alexey Kirichok] from [Sberbank].

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Unidentified Analyst, [12]

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I have three questions. Maybe I'll ask them one by one. So last week, it was reported that the other big diamond miner will allow its buyers to reject half of the diamonds that are smaller than 3/4 of a carat. In your opinion, are there any problems with the demand for small diamonds now? So what can you say about this?

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Yevgeny Yuryevich Agureyev, Public Joint Stock Company ALROSA - Director of United Selling Organization & Member of the Executive Committee [13]

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Yevgeny Agureyev, I will answer this question. Yes, last week, the other company announced some changes in the sales approach. And we think that this period of time, it's important to bring some more flexibility to our customers. And I would say that we are doing the same, and we started to do this from the first quarter of this year because in accordance with our approach, ALROSA, we are asking the clients [be sure] the type of goods, so we have some [volition] there. Customers, they are deciding not to buy the goods. So there is some lenient on obligation to buy. But the rest, we're not asking to buy them, not buyback or to (inaudible). In our case, we reduced this obligation from 70% at the beginning of the year. Now it's 55%. Also we decided to use this level for both, for long-term agreement and our request for extra goods or -- and -- what did the other company, so they decided for 1/3 of their normal goods for 1/3 of this part to use 50% lenient, and they will not ask clients to buy this type of goods. And they decided to use the support for the low efficient diamonds. So asking -- answering your question, I would like to mention here that first of all, it's important to bring flexibility. We are doing the same. And we don't see any decrease in the demand for the low-sized goods. So as I have -- and I have answered already on this question that we see, right now, budding demand. And also we don't see any significant impact on synthetic on this type of goods near term.

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Sergey Sergeevich Ivanov, Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board [14]

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It's Sergey Ivanov. I would just like to add that according to our information, we also see that some factories in India, they're actually loaded with cheap goods or small goods because it's easy to sustain operations within the current market conditions with loading factories with cheap goods. So actually, we don't expect any deterioration of demand for low-end goods.

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Unidentified Analyst, [15]

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Okay. All clear. And my second question is already partially answered, but just maybe a quick follow-up. Could you please provide any guidance on your product mix dynamics, probably compared -- if comparing the second half of this year and first half of this year? Can we probably see some improvement in the product mix and increase in average [realized price]?

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [16]

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This is Alexey. It's -- I can only give you the -- our view on the next year because for the next year, we know -- at least, we have an idea of what the production profile will be. Speaking about the third and the fourth quarter, it will be mostly driven by the markets and the available goods. And Yevgeny already answered the question. So speaking about the next year, our average value of stone will decrease by roughly 3%. And you could expect that the same decrease will be reflected in our selling prices, assuming that the price index will not change.

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Unidentified Analyst, [17]

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Okay. Understood. And the final question. So if assuming that there is no recovery in the diamond market in the next year, is there any potential to decrease CapEx guidance for next year from current guidance of RUB 26 billion? So what could be the size of this decrease in CapEx guidance, if assuming there's no recovery?

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [18]

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I'll take this question. The decrease in CapEx in 2019 is driven by shifting some of the projects into the next year, not by starting doing some of the projects. So we believe that more or less, the guidance for 2020 and 2021 for CapEx will be in the range between RUB 26 billion and RUB 28 billion per year.

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Sergey Sergeevich Ivanov, Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board [19]

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Of course, if we see some, theoretically, further deterioration of demand and some unpleasant scenarios, if I may put it so of course, we will sit down together with our shareholders and discuss the investment problem as well. But we don't see that -- we don't expect such a scenario within the next, at least, 3 to 5 months.

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Operator [20]

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Our next question is from Stella Cridge, Barclays.

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Stella Cridge, Barclays Bank PLC, Research Division - Head of EEMEA Corporate Credit Research [21]

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And if I could ask 2 questions. The first is given your balanced sales strategy, I was wondering if you had any, kind of, idea or guidance of what you're working capital and [mix] may be in the second half of the year? And the second question would be, so obviously you've made some announcements on -- you have some expectations on the dividend side. And well, also the cash balance remains fairly high. Do you think that you have to go out to seek any external financing to cover any of your needs in the near term? That'll be great.

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [22]

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I will take this question. We expect that the working capital at the end of the year will be at around RUB 95 billion to RUB 100 billion. There is about RUB 5 billion to RUB 10 million increase from where we are now, and that increase will be driven by the change in sales guidance because, again, we'll produce 38.5 million carats for this year. And our sales guidance is 32 million to 33 million carats. So this inventory will be accumulated. And as Sergey mentioned, storing these goods does not require any extra cost. Speaking about our finance requirements. The company is very well financed. We do have a large cash balance. As of today, this cash balance will be partially maintained in line with our new financial policy, that requires us to keep at least RUB 25 billion in cash at any given moment. The extra cash will go to pay dividends for the first half of 2019. As we mentioned earlier, on Monday, there will -- the Board will consider decision to pay 100% of the free cash flow in dividends for the first half of 2019. But currently, again, our debt portfolio is comfortable, and we do not see at least for the next year, any large requirements for external borrowings.

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Operator [23]

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Our next question is from Anna Antonova, JPMorgan.

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Anna Antonova, JP Morgan Chase & Co, Research Division - Analyst [24]

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Question from our side. Well, looking back at the history of the diamond markets, I recall that similarly dire market conditions were witnessed back in 2015. From your perspective, what this year -- how the situation this year is different or similar to the conditions we saw back in 2015?

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Yevgeny Yuryevich Agureyev, Public Joint Stock Company ALROSA - Director of United Selling Organization & Member of the Executive Committee [25]

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Thank you for the question. I will take it. It's Yevgeny. Yes. There are different opinions regarding this year and -- if we're trying to compare it with the 2015. But our opinion is that this year is much more difficult and because this period of time have more problems, more reasons as opposed before. And first, I think is the overall ore production level. We saw quite good demand in 2017, 2018 for the rough good. And will be a question how the jewelry industry and mixing will utilize this volume. So now we see that there is a case, there is problem with utilization of this volume.

So the second thing is retail changed a lot in their business model. And with the growing online, with the -- working with the last-minute request for the goods. And now retail moved all the stocks to midstream midterm through the finances. And now we have the judging. The judge issue with the financing questions for the industry, especially in India. We saw some scandals at the beginning of 2018 in banking industry inside in India because of the fraud cases. And now banking sector in India is also under restructuring and also India is implementing Basel 3 requirements.

So then other thing is political issues. And this year, it's much more complicated based on this due to trade war, U.S., China, and also Hong Kong and China situation. And that is something new. And we haven't saw it before. And we should keep in mind that Chinese, the second one launches the market for jewelry goods in world. And also China produce almost 60% of the jewelry goods for the U.S. market. So that is the summary of the crisis for this year. But the forecast and our expectations are that, based on the lower occasion of the rough volumes this period of time, at year-end, we should create some deficit on the market. And that is a thing that -- the right answer to the current situation. Thank you.

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Sergey Sergeevich Ivanov, Public Joint Stock Company ALROSA - President, CEO, General Director, Chairman of Mgmt. Board & Deputy Chairman of the Supervisory Board [26]

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We are in a perfect storm. If you look at 2015, there were 2 factors. There was a supply block in midstream, and there was a decreased consumer confidence. Today, we're seeing 2 more factors such as Yevgeny said. There's a change in inventory management practices driven by consolidation and shift of the sales online in the retail, especially in the U.S., that decreases the requirements for the inventory in the downstream. And there's this fall-off from the financing scandal in India that has been felt by our midstream. So I would agree that this year the situation is substantially more difficult than it was in 2015, essentially, the worst it's been since 2009.

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Anna Antonova, JP Morgan Chase & Co, Research Division - Analyst [27]

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And then just the follow-up. So if you're saying that this year is much more difficult, and there are additional problems and challenges that the industry is facing, including the, as you said, political issues, trade wards, change in the retail business model, then what are the key drivers behind your, maybe, more optimistic outlook for the remainder of this year and perhaps going into next year? Because as we're currently seeing from the price levels and sales volume, neither your sales volume year-to-date nor of your major peers, they're -- still are not at lows seen in -- back in 2015. So you're still selling higher volumes. So it seems that there is still room for sales cuts, the prices are still a bit higher and, again, there are more challenges on the buyer side. So what are the key drivers for your optimistic outlook?

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Alexey Nikolaevich Philippovskiy, Public Joint Stock Company ALROSA - CFO & Member of the Executive Committee [28]

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Anna, I would not call our current outlook for the rest of 2019 as very optimistic. In fact, we just revised our sales guidance from 38.4 million carats to the range between 32 million to 33 million carats for this year. So -- and that reflects the difficulties that, again, I just spoke about. However, we do believe that come September and October, the midstream will have to start restocking for the Christmas and the Chinese New Year sale seasons, I mean they have to start buying. The question is how pronounced that rebound will be. And speaking about 2020, at this point, it's very difficult to have a good visibility on 2020. I think we'll be in a better position to give you better guidance after we see the level of recovery, if it will take place in September and October of this year. So probably at our third quarter disclosure, we will be able to tell you more about this.

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Anna Antonova, JP Morgan Chase & Co, Research Division - Analyst [29]

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Understood. My point was just that although you have cut your sales guidance for this year, it's still above the 30 million carats you sold back in 2015. So it seems that there is potential some room to grow.

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Operator [30]

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(Operator Instructions) We have no other question at this moment. Dear speakers, back to you for the conclusion remarks.

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Sergey Takhiev, Public Joint Stock Company ALROSA - Head of Corporate Finance [31]

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Okay. Thank you for all participants on this call. I would like to

(technical difficulty)

and I encourage you to ask questions to Investor Relations team of ALROSA, if you have them. Have a nice day.

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Operator [32]

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Ladies and gentlemen, this concludes today's conference call. You may now disconnect.